Babajide Komolafe, Asst Business Editor
20 July 2005
Lagos — THE Nigeria Deposit Insurance Corporation (NDIC) yesterday accused banks and other financial institutions of manipulating their accounts to deceive the public about the true state of their financial position. The accusation by the regulator is coming on the heels of the banks seeking public offer, giving robust accounts and mouth watering promises to the public.
Speaking at a workshop organised by the Nigerian Accounting Standard Board (NASB), Managing Director /Chief Executive of NDIC, Mr Ganiyu Ogunleye, said banks not only engaged themselves in undesirable practices in financial reporting, but were also going against the standard practice of accounting in income recognition; loss recognition; and balance sheet classification by falsifying their records.
He said: "Some banks continued to use the off-balance sheet treatment of Bankers Acceptances and Commercial Papers to understate their credits and deposits. Some have also used such instruments to repackage their non-performing loans to evade provisioning while recognising incomes. Apart from the use of BAs and CPs, some banks resorted to the use of Promissory Notes (PNs) to achieve the same objectives. Yet the standards are specific on how and when to treat transactions as off-balance sheet engagements.
Implications
"The implications of understatement of assets and liabilities through the misuse of BAs and CPs are that banks' liquidity are boosted, capital adequacy ratios are enhanced, cash reserve requirements are lowered, reduced deposit insurance obligation, while return on assets and other efficiency ratios are enhanced. The bank's financial condition may therefore be distorted.
"Some banks attempt to structure their credit facilities as Banker Acceptance/Commercial Paper to make them saleable. Thus, after providing funds to the borrower, they resort to matching of a pool of customers' deposits to the value of BA/CP or, sometimes request depositors to invest in undisclosed instruments.
"In practice, the purported sale is done with recourse because there is no contractual relationship between the buyer and the issuer of the instrument. As a matter of fact, the buyer does not know the issuer. Even when he does, he looks up to the bank whenever he wants his money or upon the maturity of his purported investment, placemen or deposit.
"Besides, the control over economic benefits of the asset said to have been sold is not passed to the buyer because of a large spread between the interest paid by the issuer and the amount payable to the investor. For a sale to be true, there must be a clear break and the asset must not be within the reach of the liquidator Besides, the entire benefit of the transaction must pass to the buyer.
"Some banks had cause to borrow from international organisations such as IFC and AFREXIM. These borrowings, which are for on lending to Nigerian entities, are not being accurately reported by the banks. Whereas the agreements with the foreign lenders often refer to the Nigerian bank as the borrower, the banks involved continued to treat such obligations as contingent.
"Thus, instead of reporting such borrowing on the balance sheet, they chose the off-balance sheet reporting -- claiming that the obligation is that of the ultimate user of the fund without reference to the agreement with the lender which makes them the primary obligor. It was indeed this type of treatment for NEXIM loans that contributed largely to the collapse of some banks now in liquidation because their direct obligations on such facilities were masked by the contingency treatment.
"Apart from the misreporting of BA/CP, there is also the problem of inaccurate reporting of Open Buy Back (OBB) transactions. A bank takes an inter-bank placement from another and pledges an equivalent amount of Treasury Bills (TB) as collateral. Ordinarily, the bank that pledges its TBs to support its inter-bank takings from another is expected to report the pledged TBs as other assets. "However, the practice in some banks had been to report such TBs as part of their holdings of liquid assets when in actual fact they do not have access to them during the period that they remained pledged as collateral. The implication is that such treatment resulted in higher liquidity ratios than the affected banks actually attained. In a similar manner, some banks adopted a system whereby they finance the 'sale' of their holdings of BAs/CPs. Typically, a bank places money with, for example, a discount house. The discount house, in return, 'invests' the placement in the BA/CP held by the bank. The bank, therefore, enjoys the benefits of liquidity provided by the purported sale and an additional liquidity benefit from the placements.
"With the foregoing, some banks claimed that they have sold such BA/CP or Promissory Notes to the depositors and consequently, report the full values of such loans and matching deposits as off-balance sheet engagements -- even where the purported investor is not privy to the arrangement. Besides, they failed to comply with the necessary accounting requirements that:
lA transfer of reported credit without recourse to the seller should be accounted for by the seller as a disposal and the risk asset excluded from the balance sheet.
lTransfer of reported credit, with recourse to the seller, which purports to be a sale must satisfy the following conditions: Control over the economic benefits of the assets sold must be passed to the buyer; The seller can reasonably estimate its obligations under the recourse provisions; There must not be any re-purchase obligation or option involved, except as stipulated by the recourse provision
Accounting standard
According to Ogunleye: "Accounting standards stipulate the criteria for income recognition, it among others, states that interest income or discount on loans, overdrafts and other risk assets, should be recognised so as to record a constant yield on the outstanding principal over the life of the credit at the interest rate applicable to the facility. They also stipulate when credit related fees should be recognised or deferred and amortised over the life of the related credit while losses should be recognized as soon as they can be reasonably estimated.
"Although banks are largely compliant with the treatment of interest income, the position is not exactly the same for credit-related fees and commissions as they are usually recognised immediately a facility is booked or when the commission is due even though some might not be performing."
Ogunleye said although banks were expected to make full provision for all losses as soon as they could be reasonably estimated, some banks did not do so. He said: "Losses can arise on any asset considered doubtful of being realised in full. Such losses can include loan loss provisions, provisions against diminution in the value of other assets and other loss contingencies. However, contrary to the general principles enumerated in the Standards and the supplementary provisions contained in the Prudential Guidelines, some banks have either failed to comply, or have tried to circumvent the requirements."
He said the CBN and NDIC have always insisted on banks applying the provisions for loans and other known losses determined by their Bank Examiners.
"The BA/CP strategy is also used to misrepresent end of the month returns to the regulatory authorities in some capes. Some banks usually repackage their existing loans and advances as BA/CP at the end of the month and report them as off-balance sheet engagements. Once the re-packaging is done, a discounted value of the BA/CP is credited to the debtor's account to reduce the outstanding loan for end-of-the month reporting. Such entries are usually reversed a few days later in the succeeding month to return the outstanding balance on the account to status quo ante.
The attraction is for the bank to present a financial statement that meets regulatory obligations such as single obligors' limits, capital adequacy ratios.
"Some banks use their inter-branch accounts for questionable transactions. So also is the use of Suspense Accounts. As a matter of fact, many Suspense Accounts have been noted to contain fraud-related transactions, hidden expenditures or other undisclosed transactions, which if reported accurately, would have reflected the true financial position of some banks. It is our expectation that the NASB will note these observations and establish appropriate standards to deal with them," Ogunleye said.
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